Let’s start with some of the basics: what, why, and how?
The Research and Development (R&D) tax credit is a remarkable opportunity for businesses to spur growth and innovation. Congress designed this credit to reward businesses that invest in research and development activities that create jobs and advance the economy domestically.
To claim this credit, first, you must conduct qualified activities within the U.S. Secondly, you must incur qualified expenses in a taxable year. Third, you must carry on a trade or business.
Qualified activities mean activities that satisfy the following four requirements:
- activities intended to develop or improve a product, process, formula, or software, and
- intended to resolve technical uncertainties or unknowns at the outset. Technical uncertainties are uncertainties related to the design, method, or capabilities, and
- in carrying out experiments to resolve the technical unknown in point #2, and
- all the works above relied on natural sciences: biology, chemistry, physics, engineering, or software engineering.
Once a taxpayer determines that its activities meet those four requirements, it can include the following three types of cost: wages for employees who conducted the qualified research activities, R&D supplies, and 65% of contract research.
Then the credit is calculated as a product of the credit rate (20% or 14% depending on the method employed) and the qualified research expenses over the base expenses. The calculations sometimes are more involved based on each business’s facts and circumstances. However, in general, you can think of the benefit as a return of 10 cents for each dollar spent on qualified research expenses.
Why should you be concerned with claiming this credit? Yes, it does sound like a lot of work, but the reward is worth it. Many large and medium-sized corporations have benefited (in hundreds of millions) from this credit since the ’80s, so why shouldn’t you? In addition, any unused credits may be carried forward for 20 years or be monetized into a payroll credit to offset some FICA taxes for the employer if you are a start-up.
